The Federal Reserve’s policy committee is split on the strength of the U.S.
labour market, raising the possibility that the central bank could move to raise
interest rates sooner than many on Wall Street currently expect.

There remains little doubt that the Fed will leave its benchmark lending rate
unchanged for the rest of this year and into 2015. Yet the minutes of the
committee’s July meeting, released Wednesday, show divisions over the timing of
the move are broader than previously thought. Bond yields rose after the
release, as investors quickly recalibrated their expectations for Fed
policy.

Market View

Philadelphia Fed president Charles Plosser cast the lone dissenting vote in
July, but the minutes show other policy makers share his view that the economy
could be growing faster than the Fed realizes. The minutes portray a lively
debate about the pace of hiring amidst a general agreement that improvement is
happening faster than most of the committee’s members had expected.

“Many participants noted that if convergence toward the committee’s
objectives occurred more quickly than expected, it might become appropriate to
begin removing monetary policy accommodation sooner than they currently
anticipated,” the minutes said. In fact, “some participants” already think the
economy is strong enough to “call for a relatively prompt” move toward a higher
benchmark rate to get ahead of a jump in inflation, the minutes said.

The unemployment rate was 6.2 per cent in July, down from 6.6 per cent at the
start of the year and effectively at the level Fed policy makers predicted it
would touch at the end of 2014. Employers added more than 200,000 jobs for six
consecutive months through July, forming one of the most consistently strong
stretches of job creation on record.

Nonetheless, many of the Fed’s leaders, including the chair, Janet Yellen,
are skeptical the standard measures used to monitor the labour market are
sending a true signal. The minutes note that “many” participants were concerned
about the “large gap” between the broad unemployment rate and elevated levels of
longer-term unemployment and part-time workers seeking more hours and a low
participation rate. The policy committee ultimately voted nine to one to leave
its stimulative policies in place, citing “significant underutilization of
labour resources.”

The suggestion in the minutes that the consensus for aggressive monetary
stimulus is eroding will put a brighter spotlight on Ms. Yellen’s speech Friday
at the annual gathering of central bankers and economists in Jackson Hole, Wyo.
The event has emerged as an important one on the Fed calendar because previous
chairmen used it to signal a shift in policy or outlook. The theme of this
year’s symposium is on labour markets.

“The tone of the minutes were clearly more hawkish than expected,” said
Adrian Miller, director of fixed income strategy at GMP Securities in New York.
“It seems the committee may be closer to a rate hike decision than Chair
Yellen’s recent comments would suggest.”

The Fed already has made clear that it intends to end its extraordinary
bond-buying program in October, reflecting confidence in the economy’s momentum.
The next question is when to raise the benchmark rate, which has been pinned
effectively at zero since the end of 2008.

While opinions vary, Wall Street economists generally were predicting the
first increase will come no sooner than June of next year. Mr. Miller said the
minutes increase the likelihood that the Fed will raise interest rates in the
second quarter of 2015. Economists at BNP Paribas, who predicted earlier this
year that the benchmark rate would rise next summer, acknowledged there is now a
“risk” the Fed could move as early as the second quarter.

Fed officials discussed the mechanics for lifting their benchmark fed funds
rate, which sets the price for overnight loans between financial institutions.
The minutes show that the majority on the committee believe they can pull the
fed funds rate higher by raising the rate the Fed pays on excess bank
reserves.

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